US Federal Reserve Chairman Bernake (photo: JL Magana/AP)
For What It’s Worth
“You can ignore reality, but you can’t ignore the consequences of reality.” – Ayn Rand
Recently a friend of mine, who spent his career in the financial markets, sent me a letter about economic and financial conditions in the world. His letter is clear, succinct and easy-to-understand so I share it here because I think, for all we financial amateurs, it captures a sense of how precarious things really are. It was dated February 29, 2012 so some of the numbers will have changed but not the essence of his message.
February 29, 2012
This is not a time for risk. Be careful!
The central banks are blowing false bubbles again and creating further distortions in the financial system in a desperate effort to avoid the reality of an overly indebted western society. It’s a game called “extend and pretend.” Remember, liquidity does not solve solvency issues!
This cannot end well for most of us.
So, what do we make of U.S 10-year treasury rates at 1.9%, reflective of a weak economy and lingering deflationary fears, while at the same time the U.S. stock market is approaching the highs of last year, reflective of increased confidence in the economic recovery and modestly better corporate profits? Why are both these happening at a time when the U.S. budget is on a path to another one trillion dollar plus annual deficit for the 4th year in a row, with total public debt just surpassing 100% of GDP? When Mr. Obama took office, gross Federal debt stood at $9.1 Trillion. Today, at $15.5 Trillion, it has risen close to 70% in less than three years.
US debt clock, Times Square, New York. The above numbers are out of date and much larger today (photo: Matthews/AP)
The answer, it would seem, lies in the actions of the central bank and the oft noted policy of “financial repression.” QE 1, QE 2, ZIRP, Operation Twist, and increased dollar swap lines. These actions by the central bank have allowed the large banks to avoid insolvency and the U.S. government to continue to spend money with impunity.
Europe has now followed America’s example. On the cusp of a run on the insolvent European banking system, the new ECB President at the end of last year launched the $1 trillion LTRO (sometimes referred to as “cash for trash”), the second phase of which was completed last night. This is nothing more than a backdoor bailout of the banks, which is, of course, nothing more than a bailout of the insolvent governments. Get it? In the process of constructing this daisy chain, and in conjunction with the so-called Greek bailout, the central planners of the EU have trampled on the democratic process, subverted the rule of law, and doomed much of the southern European population to debt slavery. How do you think this may all work out? Don’t bet on it!
While the central banks of the western world may keep this ship afloat for a while longer (the game of “extend and pretend”), absent a purging of worthless debt (both public and private) and major policy changes throughout the western political and banking systems, there is no other answer other than creating liquidity (printing money by another name). The initial results of all this additional easy money can be seen in the 25% rise in the S&P 500 since the lows of last October 2011. Is it also any wonder that since the first of the year gold is up 14%, silver is up 32%, and crude oil is up 15%? Agricultural prices have also begun to rise again.
All of the above does not take into account the trouble brewing in the Middle East or this year’s political uncertainties in both Europe and the United States.
Three words of advice: Be extra careful!
John Bartlett
